The UFSU Corporation intends to borrow $450,000 to support its short-term financing requirements during the next year. The company is evaluating its financing options at the bank where it maintains its checking account. UFSU’s checking account balance, which averages $50,000, can be used to help satisfy any compensating balance requirements the bank might impose. The financing alternatives offered by the bank include the following:
Alternative 1: A discount interest loan with a simple interest of 9¼ percent and no compensating balance requirement.
Alternative 2: A 10 percent simple interest loan that has a 15 percent compensating balance requirement.
Alternative 3: A $1 million revolving line of credit with simple interest of 9¼ percent paid on the amount borrowed and a ¼ percent commitment fee on the unused balance. No compensating balance is required.
a. Compute the effective cost (rate) of each financing alternative assuming UFSU borrows $450,000. Which alternative should UFSU use?
b. For each alternative, how much would UFSU have to borrow to have $450,000 available for use (to pay the firms bills)?

  • CreatedNovember 24, 2014
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